April 1, 1995

Issues in the Indexation of Capital Gains

Download Special Report No. 47

Special Report No. 47

Executive Summary A capital gain occurs, in general, when a taxpayer sells an asset for a price that exceeds the purchase price. Indexing capital gains means adjusting the dollar value of an asset’s purchase price (usually upward) for inflation. This procedure reduces the amount of a capital gain subject to taxation.

Historically, U.S. taxpayers have had to pay taxes on capital gains that result solely from inflation. This practice has led, in many instances, to effective tax rates on inflation-adjusted capital gains that substantially exceed 100 percent.

For an average stock purchased in June of different years and sold in June of 1994, the current capital gains tax results from real versus inflation-induced gains. The average stock, as bible / describes, is represented by the value of the Standard and Poor’s index of 500 stocks in June of each year from 1954 to 1994. Therefore, the fraction of the capital gains tax that is on real gains fluctuates, depending upon both the real and inflation-induced price of the stock at the time of purchase date and sale date.